HB 3716 
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Copy 1 



Business Cycles 



By 
WARREN F. HICKERNELL, Ph.D. 



Director, Bureau of Business Conditions, Alexander Hamilton 
Institute. Lecturer on "Panics and Depressions," School of Com- 
merce, Accounts and Finance, New York University. Formerly 
Mana£in& Editor, Brookmire Economic Service. Author, "Methods 
of Business Forecasting" and Numerous Articles on Finance. 




AMERICAN INSTITUTE OF FINANCE 



Business Cycles 



By 
WARREN F. HICKERNELL, Ph.D. 



Director, Bureau of Business Conditions, Alexander Hamilton 
Institute. Lecturer on "Panics and Depressions," School of Com- 
merce, Accounts and Finance, New York University. Formerly 
Mana£in& Editor, Brookmire Economic Service. Author, "Methods 
of Business Forecasting" and Numerous Articles on Finance. 



AMERICAN INSTITUTE OF FINANCE 
BOSTON 



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Copyright, 1922, by 
American Institute of Finance 



DCU695743 



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TABLE OF CONTENTS 

Pake 

Chapter I. The Cycle Described 

Periods of the Cycle 5 

Description of the Cycle 5 

Reaction and Depression 6 

What Our Problem Is 7 

Chapter II. Outlining the Problem 

Meeting Friendly Skepticism 8 

Why Should Cycles be Understood ? 8 

Intuition vs. Sound Judgment 9 

Developing a Correct Method 10 

Chapter III. Selecting an Index of the Business Cycle. 

What the Term "Cycle" Means 11 

Statistical Indexes 12 

Bank Clearings — A Good Index 13 

Imports and Exports ' 14 

Commodity Prices 15 

Miscellaneous Indexes of Business Conditions 16 

Charting Cycle Indexes 17 

Corrected Cycle Indexes 17 

Chapter IV. The Normal Cycle 

Normal Cycle Defined 20 

Cause of the Normal Cycle 20 

Loanable Funds 21 

Normal Condition of a Central Bank 21 

Expanded Credit Position (Gold assumed stationary) .... 22 

Expanded Credit Position (Gold reduced) 22 

International Influences 22 

Increasing the Gold Reserves 23 

Credit Deflated; Loanable Funds Abundant 24 

Cause and Effect 24 

New York Financial Barometers 25 

Conditions 1904-08 26 

Barometers of European Financial Conditions 27 



4 Table of Contents 

Pafee 

Chapter IV. The Normal Cycle {continued) 

After- War Barometers 29 

Principle Restated 30 

Practical Application of the Scientific Method 30 

What Scientific Method Means 31 

Summary of Chapter 32 

Chapter V. The "Cross-Currents" 

Cross-Currents of Two Kinds 33 

Gold Production 33 

Test of Degree of Gold Production 34 

Inconvertible Paper Money 35 

Unsound Bank Management 36 

Crops 36 

Historical Verification the Next Step 37 

Chapter VI. Resume of History of Panics 

Chief Panics, 1720-1920 38-44 

Watching the Trend of Affairs 44 



CHAPTER I 

THE CYCLE DESCRIBED 

Periods of the Cycle 

The stages of the business cycle are sometimes described by 
dividing the trend of business conditions into four periods: 

1. Business improvement — wages and profits rising. 

2. Business prosperity — incomes at high tide. 

3. Business reaction — incomes declining. 

4. Business depression — incomes at low level. 

Description of the Cycle 

First Period. At the beginning of a cycle the chief features 
of the situation are low interest rates, a buoyant bond market, a 
slow demand for labor, dullness in trade and a low level of com- 
modity prices. The active market for bonds stimulates new 
construction work. It is good business to carry out plans for 
permanent construction when long-term bonds can be sold at a 
low rate of interest, insuring a small fixed charge over a long 
period. There is an expansion of demand for iron and steel 
and other construction materials. The payrolls of factories 
and construction companies grow rapidly. The broader wage 
disbursements lead to heavier purchases of clothing and furni- 
ture. 

Second Period. Presently, business improvement grows into 
pronounced prosperity. Activity becomes feverish in this 
period. But higher prices and enlarged trade require expansion 
of bank loans. When prosperity reaches the point where the 
credit required to finance trade exceeds the supply of loanable 
banking funds, the insistent bidding for funds by merchants' 
forces interest rates to an abnormally high level. Moreover, 
to provide adequate loans to merchants, the banks reduce loans 






6 Business Cycles 

on stocks and bonds. This shifting process is a danger sign in 
the stock market. 

The high interest rates and restricted security loans kill the 
sale of bonds; the interest rate offered on new bonds must com- 
pete with the current market rate. Corporations are loath to 
issue new bonds at sacrifice prices and postpone plans for new 
construction work. Orders for steel for future delivery fall off, 
and likewise for other commodities. When the demand for goods 
for future delivery falls below the productive capacity at the existing 
price level, there is a crisis. The first half of the cycle is over. 
The crisis marks the transition from the second to the third 
period of the cycle. 

Reaction and Depression 

Third Period. The second half of the cycle, comprising the 
course of Reaction and Depression, is a reversal of the first half. 
After the crisis, demand falls rapidly. In order to avoid com- 
plete idleness, sellers of goods are forced to lower prices to effect 
distribution. Old debts are paid off. New commitments are 
made at reduced prices, so that replacements require less credit. 
Commercial loans are cut down. The banks accumulate a 
loanable surplus. 

Fourth Period. In order to employ their surplus funds, the 
banks reduce interest rates. But they are unable to find a 
demand for short time commercial loans among merchants and 
manufacturers sufficient to absorb their surplus, even at low 
discount rates. They therefore lend freely upon bonds at in- 
terest rates lower than the income yield obtainable from bonds. 
This naturally stimulates active buying of bonds. There is an 
active bond market, and large corporations plan for future ex- 
pansion. This situation marks the end of the cycle. It is the 
situation described above as marking the beginning of a new 
cycle. 

Two factors which can usually be depended on to assist re- 
covery during depression are an increase in gold production and 
a growth of efficiency in productive and inventive processes. 



The Cycle D escrib ed 7 

Gold mining becomes more profitable when low prices reduce 
mining costs with the selling price of gold remaining constant. 
Greater attention is given to the productive and inventive 
processes owing to stagnation in the speculative markets. Labor 
moves from the cities to the country in some measure when 
manufacturing becomes dull and this promotes agricultural in- 
dustry. The latter is also strengthened by the fact that 
farmers work more soberly after a financial crisis. Land specu- 
lation declines, and as hopes of becoming rich through rising 
values vanish, more attention is given to production. 

What Our Problem Is 

We shall take up the analysis of the cycle from the stand- 
point of stock market fluctuations in a later Text — "The Search 
for Bargains"- — showing how stock market buying and selling 
policy should change in the different periods of the business 
cycle. In the present Text we shall discuss how the general 
trend of each cycle is determined by a dependable principle, and 
that business forecasting may be reduced to a formula, which, 
even though not mathematically exact, is measurably scientific 
in nature and helpfully systematic. 



CHAPTER II 
OUTLINING THE PROBLEM 

Meeting Friendly Skepticism 

A master among university scholars of the past generation 
habitually challenged the originator of an academic thesis with 
the questions: 

What have you got? 

How do you know it? 

What of it? 

Such questions are frequently raised regarding the subject 
of business cycles. One prominent authority on the subject, 
after an exhaustive investigation, even suggests that perhaps the 
students of each succeeding generation will find it necessary to 
revise the theory of business cycles accepted by the preceding 
generation. We find, also, that experienced business men some- 
times exhibit skepticism regarding the possibility of forecasting 
business conditions according to a theory of business cycles. 
Some of them believe that there are too many cross-currents in 
any given business situation to make it feasible to follow a sys- 
tematic method of judging the future trend of business. 

This attitude of skepticism, of course, is not wholly surpris- 
ing. It is true that fluctuations become irregular at times owing 
to apparently unforeseeable accidents or disturbing cross-currents. 

Why Should Cycles be Understood ? 

The fact that disturbing influences are always rising to con- 
fuse and perplex us in managing our financial affairs, however, 
is all the more reason why we should seek a systematic method 
of forecasting which will enable us to look ahead with positive 
opinion and a definite policy during periods of financial unsettle- 
ment. If confusion and uncertainty can be reduced to a nego- 
tiable minimum, that is a thing worth while. 



Outlining the Problem 9 

But there are more positive and more convincing reasons for 
seeking a definite plan of judging the future according to a theory 
of business cycles. The first is that the history of the past 
century shows that prices and incomes have fluctuated up and 
down in never-ending process. The study of the subject is 
compulsory. It is impossible to avoid the ups and downs of 
the cycle. 

The second is that fortunes can be built up more quickly by 
taking advantage of the rising tide of the cycle than by any 
other method. And they can be lost suddenly when the trend 
turns downward. Even professional speculators achieve success 
only when they make their commitments with due regard for 
the underlying trend of the cycle. Those who operate merely 
by intuition eventually "go broke." Probably more than half 
of the investors who were owners of speculative stocks during 
the six-month period from October, 1919, to March, 1920 — 
perhaps over eighty per cent of them — were entirely unpre- 
pared for the drastic declines in prices which actually occurred 
in November and February, although, to those acquainted with 
the method of judging the trend of the cycle explained in the 
following pages, the signs of a coming slump were clearly in 
evidence months in advance. To depend entirely upon intui- 
tion is not a satisfactory plan. 

Intuition vs. Sound Judgment 

The history of the past one hundred years shows that the 
big swings of the cycle, though never exactly similar in different 
periods, are governed in each case by certain underlying prin- 
ciples. These principles it is possible to know and to use with 
profit at all times. It is agreed that exceptional circumstances 
are always present, and that individual judgment, based upon 
experience, is always necessary in estimating the influence of the 
cross-currents which cause irregularities in fluctuations. The 
conditions affecting trade and finance are complex, but the for- 
mulation of a plan of forecasting business conditions with some 
claim to scientific method is not difficult, provided we develop 
our method one step at a time. 



10 Business Cycles 

Developing a Correct Method 

The process of developing this method must be divided into 
three distinct departments. These divisions of study are as 
follows : 

1. Defining and picturing the business cycle. What statis- 

tical indexes can we follow in order to enable us to ob- 
serve whether a given point in the cycle is above or 
below normal? 

2. The dependable cause of the "normal cycle." What 

principal or law is always operative in every cycle, 
causing prosperity to develop after depression and 
making it certain that a crisis and a period of depression 
must follow every period of prosperity? And what 
barometers guide us in anticipating conditions? 

3. The cross-currents which cause irregularity. What are 

the forces which disturb the normal curve of the cycle 
and prevent different cycles from being alike? What 
have been the principal cross-currents during the past 
century, and which of these are likely to require our 
attention in the next ten, twenty or fifty years? 

As the first step, let us now proceed to consider the business 
cycle, its definition and graphic representation. 



CHAPTER III 

SELECTING AN INDEX OF THE BUSINESS CYCLE 

What the Term "Cycle" Means 

Two problems concern us in this chapter. First, what con- 
cept do we have in mind when we use the phrase, "business 
cycle"? Second, what statistical indexes picture the fluctuations 
of the cycle? 

Some students of the subject with whom I have talked con- 
sider business cycles to be "price cycles." To them, a cycle of 
conditions in the steel industry would be depicted by a chart 
showing an oscillation of the prices of iron and steel. Similarly, 
a cycle in the oil industry would be indicated by a rise and fall 
in the price of petroleum. A cycle of general business would be 
indicated by a cycle of commodity prices as reflected, for in- 
stance, in an oscillation of Bradstreet's index. 

Other students prefer to place emphasis upon production. 
They are interested in the physical volume of trade. A cycle in 
the steel and iron industry to them would be pictured in the 
monthly statistics of pig iron production or deliveries of finished 
steel. Taking business as a whole they would be more inter- 
ested in the aggregate tonnage of merchandise produced and 
delivered for consumption than in the trendy of Bradstreet's 
index of commodity prices. 

Personally, however, when I think of the trend of the busi- 
ness cycle, I am not satisfied with either of these methods of 
charting its fluctuations. It is true, of course, that a well- 
informed man should know whether production is increasing or 
decreasing, and also whether prices are rising or falling. He 
should study business in all of its departments. In the actual 
work of forecasting business conditions, however, I believe the 
most profitable concept is to think of the cycle as an oscilla- 
tion of the "income stream" of the community as a whole. 



12 Business Cycles 

Prosperity depends upon the purchasing power of all classes of 
people in every line of business. The incomes of particular 
groups of people or lines of industry may be temporarily de- 
pressed while the incomes of the rest of the community are in- 
creasing enough to cause general expansion in the demand for 
goods. In constructing a chart of the business cycle, therefore, 
we should arrive at something which will show us the ebb and 
flow of the total income, or "spending power," of the whole 
community. For practical purposes income and spending 
power mean the same thing. People spend all they get, directly 
or indirectly. That part of income which is saved is deposited 
in the banks, where it is loaned to purchasers of goods. 

Statistical Indexes 

Having defined the business cycle as the upswing and down- 
swing of the income or spending power of the community, let 
us seek a statistical compass, or chart, of the cycle. If we de- 
sire to chart the income of the steel industry, we must first 
multiply the tonnage produced by the average selling prices. 
For instance let us suppose that in one year the output of 
finished steel in the United States was 28,000,000 tons and the 
average selling price $50 a ton. The total value would be 
$1,400,000,000. Then suppose that in the next year the total 
output was 33,000,000 tons and the average selling price $100 a 
ton. The total value would rise to $3,300,000,000. Note that 
the price is doubled, but the value is more than doubled. The 
total value of the product represents the aggregate income of 
everybody employed in the steel industry. It measures their 
spending power. It also covers dividends and taxes and provides 
spending power to stockholders and government employees. 
But suppose the next year's production declines to 30,000,000 
tons and prices to an average of $40 a ton. The total value 
falls to $1,200,000,000. Obviously the spending power would 
decrease, for this figure indicates a decline in the gross revenue 
available for wages, salaries and dividends. 

Now, if all other industries showed proportional fluctuations 
in prices and production, we might take these statistics of the 



Selecting an Index 13 

steel industry as a faithful index of the trend of general business. 
But is this permissible? Perhaps incomes in other industries 
do not rise and fall in proportion. The total gross earnings in 
the oil, motor, copper and transportation industries might show 
a different trend. To be on the safe side we should try to 
think of business cycles as representing the tips and downs in the 
total spending power of the whole community, including professional 
men, bankers, brokers and merchants as well as the wage- 
earners in the basic industries. 

Bank Clearings — A Good Index 

Let us now proceed toward a selection of statistical indexes 
which will serve us in showing the trend of the cycle. If the 
cycle represents changes in spending power, we should first 
attempt to gather statistics of all the bank checks signed by the 
public and used to pay for goods bought from month to month. 
Fortunately, we have very satisfactory statistics of what the 
public does in the way of paying its bills. The "Financial 
Chronicle" at the end of every month publishes statistics of 
bank clearings which represent all the checks exchanged between 
banks in their daily settlements. Sometimes, of course, both 
the buyer and the seller in a given transaction use the same bank. 
In that -case the check is not sent to the clearing house. Then, 
too, many checks are cleared at the Federal Reserve Banks. 
Statistics of bank clearings, therefore, do not cover the total 
transactions of the community. 

On the other hand, some transactions reflected in clearings 
do not represent spending power. A good many wealthy capi- 
talists and speculators buy huge amounts of goods, not for 
consumption, but to sell at a profit at an early date. The 
checks signed by such men represent many times their income. 
They continue paying out and receiving back practically the 
same money every week in the year, without buying and keeping 
anything to speak of. They merely speculate. Their transac- 
tions represent a rapid turn-over in their capital, not a true 
index of their incomes. This is particularly true of stock specu- 
lators in Wall Street. In fact, bank clearings in New York 



14 Business Cycles 

City reflect speculation more than the true trend of spending 
for consumption. 

Let us state, however, that we do not care if the aggregate 
of bank clearings does not exactly equal the total spending 
power. We are interested in the trend of fluctuations and not 
in calculating statistical volumes, and, for our purpose, the per 
cent of increase or decrease in bank clearings is more important 
than the amount per capita. 

Let us conclude our discussion of bank clearings with the 
opinion that they are one of the best indexes of the fluctuations 
in the total income and therefore in the total spending power 
of the whole community. 

Imports and Exports 

As an index of the business cycle, statistics of "merchandise 
imports" have several points of merit. They represent the 
trend of the prices of the goods which a country is buying for 
consumption from foreign countries. By analyzing imports we 
can see whether raw materials or foodstuffs are coming from 
abroad in larger or smaller volume. The monthly reports of 
the country's imports are of continual interest to the student of 
Panics and Depressions. 

An especial quality of imports is that they are an index of 
commodity prices, automatically weighted according to the 
quantity of each commodity purchased from abroad. Similarly, 
merchandise exports are also a weighted price index. They show 
the trend of prices of the surplus products of a country, and 
therefore reflect internal economic strength or weakness. 

As indexes of the business cycle, however, statistics of ex- 
ports and imports have one defect. In case a country is block- 
aded during war time, foreign trade falls to a low level. The 
statistics of imports and exports in that case do not tell us the 
true tendency of the country's national income, or total spending 
power. 

It should also be noted that, as indexes, imports and exports 
differ slightly. When exports rise, it may mean that the country 
is shipping goods to pay debts abroad, whereas if imports are 



Selecting an 1 71 dex 15 

temporarily abnormal, extravagance in the consumption of 
foreign goods may be indicated, and presumably the importing 
country is getting badly into debt. In the stress of a financial 
crisis, a country which has been getting badly into debt becomes 
embarrassed, while a country which has been selling its goods 
abroad and building up a strong foreign credit balance may 
come through the panic period with little disturbance in the 
money market. 

In the long run, imports and exports are good indexes of the 
business cycle, but it is necessary to observe the qualifications 
above stated. 



Commodity Prices 

An average of the prices of important commodities is ordin- 
arily a good index of the business cycle. The wages and profits 
in any industry must be covered by sale prices, and an average 
of the prices in all basic industries indicates the trend of the 
gross income of business in general. 

One defect of commodity prices as an index is that they tend 
to seek an international equilibrium, so that the fluctuations are 
pretty much the same in all countries on a gold monetary basis. 
Because of this international similarity, fluctuations of prices do 
not reflect important differences in financial conditions in dif- 
ferent countries. If we desire to ascertain how any one coun- 
try is situated at the time of a financial crisis, therefore, it is 
necessary to study other statistical indexes which have a local 
color. 

At the present time, of course, because of the suspension of 
gold payment in the largest European countries, it can truly be 
said that indexes of commodity prices in most of the large foreign 
countries do reflect local conditions. Until gold payment is 
resumed in England and France, the commodity price indexes 
of these countries, as well as sterling and franc quotations, will 
serve to guide us in noting the progress being made toward 
deflation. 



16 Business Cycles 

Miscellaneous Indexes of Business Conditions 

Under this topic we shall mention a number of statistical 
guides which every man should keep in touch with for their in- 
dividual significance rather than as indexes of the cycle of com- 
munity income. Such indexes are pig iron production, unfilled 
steel orders, commercial failures, immigration, and building 
permits. 

Pig iron production is defective because it reflects only the 
physical volume of trade and not the aggregate money income 
of the country. Moreover, it reflects conditions in a particular 
industry and sometimes may not indicate the prosperity of the 
entire community. The same applies to unfilled steel orders. 
But the iron and steel industry is so important that it deserves 
special and constant consideration. 

Commercial failures move inversely with a country's pros- 
perity. When commodity prices decline, failures increase. Re- 
versely, when prices rise, failures fall to a low level. The chief 
defect of failures as a guide to prosperity is that they are a 
little slow in coming to our observation. Such statistical indexes 
as bank clearings, commodity prices and foreign trade are some- 
what more prompt in suggesting the cycle's trend. The lia- 
bilities involved in failures, however, would seem, theoretically, 
to be a good inverse index of the trend of community income. 

Immigration is not an especially good index of business con- 
ditions. During the European war, statistics of immigration did 
not indicate the general trend of the total income, or spending 
power, of the United States. But although they are not a good 
index of the business cycle, we should study immigration statis- 
tics in relation to the supply of common labor. As a sidelight 
they are interesting. 

Building permits have a bearing upon the amount of new 
building in prospect. They rise early in the cycle. Like stock 
market sales, the volume of bond sales and reports of new issues 
of securities, they foreshadow the future tendency of business. 
They precede the changes in the general prosperity of the coun- 
try rather than reflect the current trend of incomes. 



Selecting an I n dex 17 

Charting Cycle Indexes 

The student of charts is confronted with two confusing ele- 
ments in attempting to judge the position of the business cycle 
from a graph of "actual statistics." The true trend of the busi- 
ness cycle is partially obscured owing to seasonal tendencies and 
the general upward drift commonly known as "normal growth." 
Statisticians, speaking professionally, call this growth the "secu- 
lar trend." There are a number of ways of eliminating seasonal 
variation and normal growth. One method is to eliminate the 
seasonal variation separately and then "step down" the normal 
growth. A second method is to divide any one month by an 
average of that same month for a number of years preceding. 

Corrected Cycle Indexes 

In the following diagram of Imports we have employed a 
simple method of eliminating the seasonal and the secular ten- 
dencies, the "cyclical curve" being shown by the heavy line. 
It is clear that this corrected line is a better guide than the 
graph of actual imports (the light broken line). 

We might go a step further and average the above "cyclical 
curve" of imports with similar corrected graphs of clearings, 
commodity prices and several other cycle indexes, arriving at a 
single, composite business Index. This combining process may 
be objectionable to those who wish to study the individual sig- 
nificance of each index, but it has the advantage of concentrating 
our thought upon the idea involved, namely, that a business 
index should represent the fluctuations in the aggregate income, or 
spending poiver, of the community. 

We have stated above that bank clearings, foreign trade 
statistics and commodity prices are probably the best indexes 
of the trend of general prosperity. In the United States, how- 
ever, it is permissible to include pig iron production and pig 
iron prices, and also unfilled steel orders, because the iron and 
steel business is a basic industry and has the special significance 
of reflecting the trend of new construction work. Perhaps 
statistics of bank clearings and foreign trade alone might answer 



18 



Business Cycles 



our purpose just as well as an average of six or eight items. 
However, if the secondary items are interesting in themselves, 
there is no objection to averaging them into a single Business 
Index, which might well be called an Index of Income, because 



Mdse. imports 



, udr 




Actual and Corrected Statistics on Imports 

The above chart shows that before the war the rate of interest in London and the Bank 
of France's ratio of cash to note circulation were important barometers for the speculator 
operating in Wall Street. These barometers will again be important when London resumes 
the gold standard of payment in business transactions. But for several years ahead the 
reserve ratio of our Federal Reserve Banks and time money rates in New York will probably 
deserve prime consideration. We are not independent of European influences, but we are 
now more self-sufficient in our finances than before the war and Europe looks to us for aid, 
whereas before the war we borrowed large amounts ftom Europe. 



Selecting an Index 19 

it represents the curve of the aggregate wages and profits of 
the community during the course of the business cycle. For an 
example of an index of General Business, or General Community 
Income, the reader is referred to in the Text, "Measuring and 
Forecasting Business Conditions," where the subject of combining 
statistical graphs into one composite index is dealt with con- 
structively by Professor Persons. 

Having now pointed out the specific indexes which guide 
us in observing the general direction of the cycle, the work in 
this chapter has been completed. A more important subject is 
now ahead of us, viz., what causes the fluctuations of the business 
cycle? In raising this question, we suddenly realize that the 
above chart does not forecast anything. It merely reveals 
whether business is above or below normal. The most impor- 
tant consideration now is to arrive at a method of predicting 
whether at any time the business index will ascend or descend. 



CHAPTER IV 
THE NORMAL CYCLE 

Normal Cycle Defined 

What is the "Normal Cycle"? In actual experience no 
cycle is normal. Accidents always happen to disturb the normal 
trend. Nevertheless, there always is an underlying trend, and 
the idea of a normal cycle has a very practical value in helping 
us look beyond the temporary periods of irregularity. 

Let us regard the normal cycle as consisting of fluctuations 
above and below a horizontal normal line, the second half of 
the cycle declining exactly in proportion to the forward move- 
ment of the first half, and the area of prosperity above the 
normal line being exactly equalled by the period of depression 
which develops below the line. 

In every cycle such a condition of regularity would develop 
if it were not for the accidental cross-currents which disturb the 
normal trend. 

Cause of the Normal Cycle 

The underlying trend of every cycle — the normal trend — is 
caused by a single factor. This factor is the flow of the loanable 
funds of the banks, to and from the borrowers in a community. 
When loanable funds are abundant, they are freely lent. The 
borrowers disburse them for merchandise and wages. The flow 
of funds from lenders to borrowers leads directly to rising prices 
and higher wages. 

Reversely, when bank credit is over-extended and lenders 
exact higher interest rates, borrowing is discouraged. There is a 
general slackening in the transfer of loanable funds from lender 
to borrower. The borrower reduces purchases of commodities 
and curtails employment. 



The Normal Cycle 21 

Our method of forecasting the business cycle is simplified if 
we start with this simple explanation of the cause of the normal 
cycle. Free lending breeds prosperity. Depression results 
from restriction of credit. To forecast the underlying direction 
of the cycle it is only necessary to ask and answer the two fol- 
lowing questions: 

1. Can commercial loans expand further? If so, the normal 

trend of the cycle is still upward. 

2. Must commercial loans be restricted? If so, the normal 

trend of the cycle will turn downward. 

Loanable Funds 

Our starting point in the study of loanable funds is the state- 
ment that in normal times the central banks in the money centres 
of the world, especially London, Paris, and New York, should 
keep about half of their assets in gold. As a guiding principle 
we may say that when their assets are half gold and half interest- 
bearing paper, they are in normal condition. Let us picture 
this condition in a table showing the two principal items of a 
central bank. 

Normal Condition of a Central Bank 

Loans $2,000,000,000 50% 

Go l d ....'... 2,000,000,000 50% 

AsS ets $4,000,000,000 100% 

(Ratio of gold to loans, 100%,) 

With half the assets in gold, interest rates are usually normal. 
There is room for business to expand. Let us suppose that 
business does expand, and that the increase in the volume of 
trade with prices rising causes loans to mount higher. What 
then will be the proportion of assets in gold? As a first step, let 
us assume that loans have increased 25 per cent, or $500,000,000. 
Will the bank statement be as follows? 






22 Business Cycles 

Expanded Credit Position. (Gold assumed stationary) 

Loans $2,500,000,000 55.6% 

Gold 2,000,000,000 44.4% 

Assets $4,500,000,0000 100% 

(Ratio of gold to loans, 80%) 

No. An assumption that gold will remain stationary while 
loans increase is not true to life. It would ignore the actual 
dynamics of business activity. In actual business experience, 
the gold reserves would have decreased while loans were ex- 
panding. The above table should be corrected to read as 
follows: 

Expanded Credit Position. (Gold reduced) 

Loans $2,500,000,000 58.1% 

Gold 1,800,000,000 41.9% 

Assets $4,300,000,000 100% 

(Ratio of gold to loans, 70.2%) 

International Influences 

The explanation of the loss in gold is found in the fact that 
trade is international. When trade expands and loans increase, 
some of the funds obtained by manufacturers will most certainly 
be used to buy imported goods. For instance, in the United 
States the Central Leather, American Woolen, United States 
Rubber and Manhattan Shirt companies respectively must im- 
port hides and wool from South America and Australia and 
rubber and silk from the Orient. Then, during prosperity, the 
imports of sugar from Cuba, coffee from Brazil and precious 
stones from South Africa increase. Gold must be sent to pay 
for these imports, or at least that part of them not balanced 
by shipments of steel, copper, cotton and other American 
products. 

But this loss of gold cannot continue indefinitely. That is. 



The Normal Cycle 23 

the loss of gold must be stopped if the gold standard of payment 
is to be maintained. Of course, in an emergency, it is sometimes 
found necessary to suspend gold payment and ship an indefinite 
amount of gold out of the country. For instance, during the 
Napoleonic wars the British government shipped so much gold 
to. Austria to finance the armies fighting against Napoleon that 
the Bank of England discontinued paying its obligations in gold. 
In case of famine arising from domestic crop failure it is some- 
times necessary to make abnormal shipments of gold to foreign 
countries to procure food. These two circumstances — famine 
and military necessity — can force the governors of a central 
bank to depart from the ordinary rules of bank management. 



Increasing the Gold Reserves 

In discussing the normal cycle, however, we may assume the 
absence of famine and military necessity. Normally, it is de- 
sirable to maintain the gold standard, and to do this, after credit 
expansion has proceeded to the point where the gold reserves of 
the central bank have fallen to an uncomfortably low figure, the 
central bank normally does two things: 

1. It restricts lending, and 

2. Increases discount rates to 6, 7 or if necessary to 8 or 10 

per cent. 

Either one or both of these policies will cause congestion in 
the security markets and precipitate deflation of prices. Gradu- 
ally loans will decrease. There will be less gold needed for re- 
mittances between countries to settle trade balances, as soon as 
trade slows down and commodity values fall. Gold will accumu- 
late in the central banks. These banks will be restored to a 
normal condition, in fact, their gold reserves become abnormally 
large during a period of trade depression. For instance, in the 
following table, where gold holdings are larger than the loans, 
the supply of loanable funds may be adjudged to be above 
normal. 



24 Business Cycles 

Credit Deflated ; Loanable Funds Abundant 

Loans $1,800,000,000 45% 

Gold 2,200,000,000 55% 

Assets $4,000,000,000 100%, 

(Ratio of gold to loans, 122.2%) 

When the bank statement reaches this point, the banks 
"breathe easily," and there is a fall in interest rates which 
favors a revival of financial activity. 

Cause and Effect 

The business cycle, then, is the direct resultant of the flow of 
loanable funds. 

The motor which impels the cycle forward is the supply of 
bank credit. The supply of loanable funds is our "cycle gas." 
As funds are put into circulation, they swell wages and profits. 
The Business Index rises. The index of loanable funds corres- 
pondingly declines. When the pumping of new funds into com- 
mercial enterprise is at an end, wages, prices and profits come 
to a dead standstill. Then lenders withdraw their funds gradu- 
ally from the borrowers. Payrolls grow smaller. The aggre- 
gate income of the community declines. The curve representing 
the cycle falls below normal. But meanwhile there is an in- 
creasing accumulation of loanable funds. We find that the 
supply of funds is well above normal by the time the cycle 
touches the minimum of depression. WTien the supply of "cycle 
gas" is once again abundant, the normal trend of general busi- 
ness soon turns upward marking the beginning of a new cycle. 

This completes our statement of the ideal concept of the 
"normal cycle." The practical problem now is to find, in the 
actual world of finance, the statistical barometers which will 
enable us to state accurately whether the supply of loanable 
funds is abundant or exhausted, or in some intermediate posi- 
tion. Needless to say, no one statistical barometer tells the 
whole story. Not all financial areas register "low barometer" 



The Normal Cycle 25 

or "high barometer" simultaneously. There are local differences 
in the United States, and very frequently the financial resources 
of Paris, Berlin, and London exhibit differing degrees of abund- 
ance or depletion. Then, we must always consider the flow of 
gold toward South America, Asia and other parts of the world. 
The idea of a world reservoir of loanable funds is a simple con- 
cept in the abstract, but in actual practice, a careful survey is 
necessary to grasp the situation as a whole. 

We find, however, that indexes of money conditions in New 
York, London and Paris usually satisfy our requirements for 
mechanical barometers. Conditions in the rest of the world are 
visualized in the financial barometers of these three cities to a 
large extent. To illustrate this point let us make a special 
study of the cycle culminating in the Panic of 1907. 

New York Financial Barometers 

What are the best financial barometers of conditions in 
Wall Street? Perhaps the average investor would care little 
about a mechanical index based on statistics if he could lunch 
at the Waldorf Astoria with a prominent New York banker and 
derive his information regarding the financial outlook during 
the course of the noonday conversation. In our opinion, how- 
ever, less could be gained from such a conversation than can be 
learned from an analysis of the reserves, loans and deposits of 
the banks in the New York Clearing House which are published 
every week. We not only have the statistical information which 
the bankers possess, but every day in the week we can ascertain 
the opinions of the bankers themselves regarding their own 
statements. If a banker thinks his balance sheet is growing 
worse he will increase his discount rate. If he has on hand an 
abundant surplus of loanable funds, a very low rate of interest, 
(published in the newspapers) will give us positive evidence of 
the fact. Thus, by following the changes in the items of the 
balance sheets of the banks every week and the interest rates 
quoted in the papers every day, we can know accurately what 
the banking situation is and what the bankers think about it. 



26 



Business Cycles 



Conditions 1904-08 

Let us put this system to a practical test during the period 
from 1904 to 1908. We shall select two items from the New- 
York bank statement, namely, the percentage of loans^to de- 




Money Conditions in New York 



posits and the ratio of reserves to loans. These two items tell 
us the condition of the banks. Having plotted these statistics 
on a chart, let us add a line showing interest rates in New York. 
We have now a picture of money conditions in New York as 



The Normal Cycle 27 

shown in the diagram on opposite page. The interpretation is that 
as there is a rise in the percentage of loans on deposits, and a fall 
in the ratio of reserves to loans, the banks elevate interest rates 
to check borrowing. Reversely, when reserves rise and the ratio 
of loans to deposits falls, interest rates are lowered, as in 1908. 

Barometers of European Financial Conditions 

Meanwhile, what is the situation in Europe? And what 
indexes shall we select from London and Paris? In the period 
1904-08 the important indexes in London were the cash reserve 
of the Bank of England and interest rates in London. In Paris, 
the chief barometer was the condition of the Bank of France. 
Paris held more gold than London, hence the importance of the 
Bank of France as a source of assistance to London in time of 
need. But London held more American securities than Paris, 
hence the rate of interest in London decisively affected the 
prices of American securities. In charting European barometers, 
then, let us plot the ratio of reserves to note circulation of the 
Bank of France at the bottom of our chart, and immediately 
above it the official bank rate of the Bank of England. 

Now, we can add a graph of prices of American stocks and 
we are ready to judge the effect of European conditions upon 
the New York Stock Market during 1904-08. 

Our first impression from this diagram is that activities in 
Wall Street move very promptly in discounting conditions in 
Europe. For instance, when Paris and London reflected easy 
money in 1904, the stock market advanced enough during 1904 
and 1905 to discount all of the prosperity which was to develop 
during 1906-07. Then in 1907 the stock market declined more 
than enough to measure the depression which developed during 
1908. In the latter year, even before Paris was financially 
normal, Wall Street proceeded to anticipate the outlook for im- 
provement abroad. The resources of the Bank of France did 
not entirely recover until 1909, but by the time financial condi- 
tions were approaching normal in Europe, the New York Stock 
Market had recovered most of the loss suffered during the Panic 
of 1907. 



28 



Business Cy cle s 



Our conclusion, then, is that although conditions in Europe 
had a fundamental relation to speculation in Wall Street during 
1904-08, the American investor had to be alert and foresee 




i wt I i<?os' 1 /yo& T 1407 \ 1 90s 1 / qoq 

Stock Prices and Money Conditions Abroad 

This chart shows the relation between the prices of stocks in New York and financial 
conditions in London and Paris. 



what was going to happen in Europe if he wished to profit from 
his knowledge of foreign conditions in actual stock market 
operations. 



The Normal Cycle 29 

After-War Barometers 

It is appropriate at this point to suggest that the American 
investor should change his point of view in analyzing the finan- 
cial conditions of Europe owing to the fundamental changes 
wrought by the war. The prime consideration in 1907 was that 
England owned over four billion dollars of American securities. 
British investors would buy American securities when interest 
rates were as low as 4 per cent, but they would sell back to New 
York whenever London interest rates were 6 or 7 per cent. 
Since 1914, however, perhaps over half of the American securi- 
ties formerly owned in England have been returned to the 
United States. "Foreign selling" is not such an important 
factor as it was a decade ago. 

Another point is that a rise in the bank rate in London is no 
longer a signal for the selling of American securities by British 
investors. That process is obsolete because England is now on 
a paper money basis. The rate of sterling exchange is the im- 
portant barometer because when sterling exchange is low and 
dollars in London are correspondingly high, English investors 
can realize a handsome price in London by selling American 
securities. 

The rule is that a drop in sterling exchange induces English 
selling in New York, whereas a rise in sterling lessens the pres- 
sure upon the New York market. This applies, moreover, 
mainly to bonds, as foreign holdings of Steel Common and rail- 
way stocks are no longer formidable. 

Another change in the point of view is that London is no 
longer the central barometer in the investment situation. For 
some years to come London will be more affected by conditions 
in New York than the contrary. That is, whenever money con- 
ditions are easy in New York there will be an increase in lending 
to England and France. This increased lending will stimulate 
exports of American goods. This will be favorable to American 
industrial stocks. 

Still another important point in judging the money market 
is that we no longer turn to the weekly condition of the New 



30 B u si n ess Cycles 

York Clearing House Banks as the most important financial 
barometer in Wall Street. The central barometer for the entire 
world is the combined statement of the twelve Federal Reserve 
Banks. However, the statement of the New York Reserve 
institution has a more direct bearing upon the stock market 
than that of the Reserve System as a whole. The New York 
Reserve Bank is a bell-wether for the seventy or more members 
of the New York Clearing House. Moreover, the Reserve 
Bank in New York bears the brunt of a crisis in its early stages. 
It is the most important stock market barometer. 

On the other hand, we should not ignore the banking situa- 
tion in Chicago or San Francisco entirely. Our method should 
be to follow closely the situation in Wall Street, and then studi- 
ously compare conditions in London, Paris, Philadelphia, Chi- 
cago and other American centers. 

Principle Restated 

To recapitulate, the supply of loanable funds is the most 
important single factor in determining the trend of business 
conditions. The scientific method of forecasting business con- 
ditions is to study loanable funds as the keystone in the arch 
and then take up separately the cross-currents, such as gold 
production and bank management, and ask the question, "How 
will each one of these cross-currents affect the supply of loanable 
funds in the immediate future?" 

Practical Application of the Scientific Method 

For instance, at the end of 1919 it appeared that the normal 
cycle had nearly culminated. On the assumption of a normal 
banking policy, there was little chance of any further inflation 
of credit. Sound banking policy demanded immediate credit 
restriction and early price deflation. A scientific forecast at that 
time then would have been : 

"The culmination of the cycle is at hand and the underlying 
trend from now on will be downward, unless extreme irreg- 
ularity is produced by some cross-current." 



The Normal Cycle 31 

The investor would then proceed to consider each cross- 
current separately as follows: 

1. "Can gold production cause further inflation?" The 

answer in December, 1919, was "No." Gold produc- 
tion was subnormal. 

2. "Can crop conditions cause further inflation?" The 

answer was "No." It was known that the acreage for 
the next winter wheat crop was less than the preceding 
year. 

3. "Can politics cause further inflation?" The answer was 

"No." Unless Congress might authorize new loans to 
Europe. 

4. "Can inflation of credit in England or France cause prices 

to rise in the United States?" The answer was "No," 
as foreign inflation would merely cause the foreign 
exchanges to drop, and this would depress prices in 
America. 

5. "Can the Federal Reserve Board permit further inflation?" 

Here the answer was "Yes, to some extent." But to do 
so it would be necessary to violate the intention of the 
regulations established by Congress in the original 
Reserve Act. Gold reserves were already low and 
interest rates were approaching abnormal levels. 

This method of surveying a situation is practiced by the 
most able and farsighted bankers in Wall Street in formulating 
their financial policies. 

What Scientific Method Means 

Our conclusion is that a forecast formulated by this method 
will always be valuable. In the above case, the underlying 
trend, as determined by the supply of loanable funds, had 
reached its crest and could not continue upward except by further 
loans to Europe or excessive credit extension by the Reserve 
Board. It is true that these cross-currents were important un- 
certainties. However, after eliminating the minor factors and 



32 Busines s Cy cles 

giving proper weight to these two major uncertainties, the in- 
vestor was in a position to arrive at an approximately perfect 
judgment of the outlook? His future problem was to keep in 
touch with the banking situation and make mental allowance for 
whatever changes in crops and politics might occur. 

Scientific method in forecasting consists in establishing a 
principle for determining the trend of the normal cycle in any 
situation, and then, in a given situation, in according due weight 
to such cross-currents or accidental factors as can disturb the 
normal trend. 

Summary of Chapter 

The causal influences which govern the fluctuations of the 
business cycle are of two kinds: (1) accidental and (2) normal. 

The normal, or regular, cause is the supply of loanable funds. 
It is operative in every cycle. If it were the only influence to 
consider, each succeeding cycle would be just like all of its 
predecessors. We know, however, that no two cycles are exactly 
alike. The reason is that there are always accidental cross- 
currents operating to produce irregularity. The nature of these 
cross-currents is the subject of the next chapter. 



CHAPTER V 
THE "CROSS-CURRENTS" 

Cross-Currents of Two Kinds 

The cross-currents which disturb the normal trend of the 
cycle are of two kinds: 

1. Those governing the primary moves of the cycle. These 

"big swings" continue for a year or two. 

2. Those which influence the short periods of irregularity, 

or seasonal fluctuations, which are of only three or four 
months' duration. 

Among the cross-currents of the second class, whose influ- 
ence as a rule extends over a period of only two to four months, 
are court decisions, some legislative acts, diplomatic disputes, 
important elections, the outbreak or termination of a war, and 
minor crop changes. The discussion of these short swing in- 
fluences really belongs in the Text on "TheSearch for Bargains," 
and not in the present chapter, for here we are primarily con- 
cerned with analyzing the influences which shape the underlying 
trend of the primary moves of the cycle. 

Among the cross-currents which fundamentally govern the 
duration of periods of prosperity and depression, the following 
are the most important : 

1. Gold production. 

2. Inconvertible paper money. 

3. Unsound bank management. 

4. Crop changes of cardinal importance. 

Gold Production 

The important thing to consider regarding gold production is 
whether the world supply of gold, especially the part used for 
bank reserves and for monetary circulation, is increasing faster 



34 Business Cycles 

than the physical volume of trade. The rules for judging the 
relation of gold production to the trend of business are: 

1. If new gold is coming into circulation faster than the 

annual demand for the metal for monetary purposes, 
the business cycle itself will show a decided upward 
drift. That is, after the cycle has culminated and the 
crisis has been followed by a period of depression, it 
will be found that prices, wages and profits will not be 
as low at the end of the cycle as they were at the begin- 
ning. The upturn of a new cycle will appear with 
little delay. 

2. If gold production is not increasing fast enough to satisfy 

the demand for monetary purposes, however, prices, 
wages and profits at the end of the cycle will be lower 
than at the beginning. It will take longer to accomplish 
the readjustments necessary to put business on a sound 
basis. There will be tedious delay in planning for the 
upturn of a new cycle. 

Test of Degree of Gold Production 

But what indicates whether gold production is subnormal or 
excessive? It would be difficult to answer this question, but 
the relative amounts of gold and paper in the assets reported 
by the banks indicate the progress of readjustment. When the 
banks have too much paper and too little gold, a cycle cannot 
begin. There must be either a reduction of paper assets or an 
accumulation of gold reserves, or both, until the distribution of 
assets shows a normal proportion of gold. If gold accumulates 
rapidly and becomes abundant, a new cycle can begin without 
deflation of paper assets, even though the banks may have 
accumulated an unusually large supply of paper in their assets 
during the preceding period of prosperity. 

Let us adduce historical illustrations. Probably the most 
rapid periods of credit inflation in history, except in war time, 
occurred immediately preceding the panics of 1857 and 1907. 
Nevertheless, within a year after each of these most frightful 



The "Cross-Currents" 35 

panics, the banks were abundantly supplied with gold because 
so many hundred millions of dollars were being added every 
year to the world's gold supply. It was not necessary to deflate 
credit for any length of time after these panics. On the other 
hand, after the panics of 1825, 1837 and 1893, the world's an- 
nual production of gold was not sufficient to enable the banks 
to go ahead without a prolonged period of tedious deflation. 

It will always be a matter of grave concern whether a crisis 
is to be followed by a long or a short period of depression. That 
is why the world's gold supply must be given thoughtful consid- 
eration in judging the long-range trend of affairs. The particu- 
lar point of concern is its relation to the supply of paper money 
in circulation. 

Inconvertible Paper Money 

In 1914 this factor did not deserve much consideration. 
Most countries were on a gold basis. In 1920, however, it was a 
more important factor than either crops or gold production. For 
instance, if England were to decide to turn about face and au- 
thorize an unlimited increase in her paper currency during the 
next five years, prices would remain higher than is actually 
going to be the case. England would then make little demand on 
the United States for gold and American business men could 
expect very little deflation in the near future. On the other hand, 
if the British Parliament authorizes a rapid contraction of paper 
money, the deflation of commodity prices will be hastened and 
America's gold reserves will be subjected to an increasing strain. 

Historical illustrations of the influence of paper money de- 
flation upon the trend of the business cycle are found after the 
Napoleonic Wars, after the panic of 1837 and after the American 
Civil War. In each case there was vacillating procrastination 
before the politicians decided to deflate, but the ultimate effect 
upon business was the same in every case. These three deflating 
periods, featured by a transition from a paper money to a gold 
basis, stand out as the most conspicuous depressions in history. 
They covered respectively the years from 1819 to 1822, from 



36 Bit si 7i ess Cycles 

1839 to 1843 and from 1875 to 1879 — all periods of three or four 
years. This suggests that we may expect quiet business while 
England and France are seriously taking action to get back to a 
gold basis. 

Unsound Bank Management 

In most business cycles it is not necessary to deal with un- 
sound bank management as an important factor. There have 
been several cases during the past century, however, when the 
upswing of the cycle was entirely due to disregard of sound bank- 
ing policy. Excessive lending by bank officials was responsible 
for the bubble which developed between 1815 and 1819 in the 
United States. It was again in evidence in the United States 
between 1830 and 1839. During the eighty years from 1840 to 
1920, however, unsound bank management does not figure in 
the development of credit bubbles to any great extent in the 
United States. 

In England there was excessive lending from 1834 to 1836 
and from 1862 to 1866; in France, from 1878 to 1882; in Argen- 
tina, from 1887 to 1890. 

The factor of bank management is a most important con- 
sideration in the United States, now that the Federal Reserve 
Banks are in operation. In fact, the inflation during 1919 and 
1920 would have been largely checked and avoided if the Fed- 
eral Reserve Board had not been guilty of unsound management 
in permitting excessive loans to be made by the Reserve Banks 
at a rate of interest below the prevailing market rate. 

Crops 

During the recent war the influence of the crops was some- 
what overshadowed by the financial inflation which was com- 
pelled by political necessity. 

During the next five years, moreover, the credit policy of the 
Reserve Banks and the attitude of the British Government to- 
ward reducing inconvertible paper currency may deserve more 
consideration than crop conditions. This will be true if the size 



The "Cross-Currents" 37 

of the crops is about the same from year to year. It is only 
when there are sudden changes in the size of the crops that they 
tend to cause irregularity in the trend of the cycle. 

Nevertheless, the size of the harvests is a factor which must 
never be ignored. The cost of living depends upon the price of 
food. When food prices are high, there is only a small margin 
of income available for the purchase of clothing and furniture 
and for investment in new enterprises. Reversely, when food 
is cheap there is a big surplus available from the aggregate in- 
come of the community for other living expenses and for invest- 
ment. This investment surplus stimulates trade and speculation. 
Large crops swell the volume of railroad traffic, increase the 
profits of the railroad stocks, and beget large orders for equip- 
ment, rails, and structural steel. The increased employment in 
the factories benefits trade, wholesale and retail. 

Historical Verification the Next Step 

Having considered the cross-currents which influence the in- 
tensity and duration of periods of prosperity and depression, 
our next step is to review the most notable financial crises of the 
past, in order to observe in actual business experience the opera- 
tion of the foregoing factors. 



CHAPTER VI 

RESUME OF HISTORY OF PANICS 

1720. The Bursting of the Mississippi Bubble in France 
and the South Sea Bubble in England. 

The inflation of the first half of the cycle arose from an ex- 
pansion of loans on stocks and realty in France by the Banque 
Royale, managed by John Law. The crisis developed normally. 
Excessive bank note circulation drove gold out of the country 
and the gold reserves of the Banque Royale suffered a drain. To 
protect the bank, loans were restricted. Prices slumped and the 
paper money became discredited. 

1763-64. Panic in Amsterdam, Hamburg, Frankfort, 
and London at the end of the Seven Years' War. 

Banks had issued currency in exchange for war securities, 
a rise in prices attending the inflation of the currency. When 
buying of war supplies ceased, inflation of credit culminated. 
Prices fell and banks restricted lending, fearing to make loans 
against depreciating values. The inflation during the war was 
abnormal, as military, necessity caused the Bank of England to 
continue increasing loans even after the point where wise man- 
agement normally would have restricted credit and forced a crisis. 

1793. Outbreak of the Anglo-French Wars caused run 
on the banks in England. 

For several years previous, price inflation and commercial 
expansion had developed normally, with loans of the Bank of 
England expanding. The crisis period was very abnormal ow- 
ing to the grave political uncertainties in the outlook. The 
British Treasury came to the relief of merchants when the Bank 
of England refused. 



Resume of History of Panics 39 

1797. Napoleon's attempt to invade England caused a 
run on the banks. 

The Bank of England suspended payment (not resuming 
until May 1, 1821). This crisis was featured by abnormal cross- 
currents. It was not a normal crisis marking the culmination 
of a cycle. Inflation went right on in connection with war finan- 
cing until the Peace of Amiens in 1802. 

1810-11. Napoleon's blockade in Europe and Jefferson's 
embargo in the United States prevented normal sale 
of British manufactures. 

The English banks loaned credit to carry British merchants 
who lost their markets, loans rising conspicuously during 1809. 
But goods glutted the markets, prices fell and industry became 
stagnant during 1810-11. 

1814-15. End of Napoleonic Wars followed by decline in 
prices and collapse of weak banks. 

Europe was impoverished and could not buy the world's sup- 
ply of goods. The chief cross-current was a collapse of credit. 
On the Continent, paper currencies became largely worthless, 
necessitating the use of gold to buy goods. There was little of 
it. 

In 1919 there was asharp contrast. Currencies were depreciated 
in Europe, but they did not become utterly worthless, and hence 
prices rose instead of falling promptly to a gold basis, as was the 
case after the Napoleonic Wars. Then, with a multitude of small 
banks failing, price deflation promptly followed the disappearance 
of worthless currencies from circulation. 

In 1919, with paper currencies largely secured by govern- 
ment bonds everywhere, there was no credit collapse, no sudden 
disappearance of paper money from circulation, and hence not 
the prompt deflation of prices witnessed in Europe in 1815 after 
Leipsic and Waterloo. Orderly deflation came in 1920. 

In 1815, moreover, there was centralized political control in 
Europe, and kings and emperors were able to keep the masses 



40 Busines s Cy cles 

of the people efficiently engaged in productive processes, whereas 
in 1919 a shortage of goods was conspicuous, partly because the 
masses had seized control and looked to paper money instead of 
economic productivity as the means of livelihood. 

1819. Crisis in America and England. 

Heavy loans to France during 1817-18. Crop shortage in 
England in 1818. Gold exported for grain and to borrowing 
countries. Loss of gold precipitated banking crisis. Depres- 
sion intensified by act of Parliament in 1819 requiring British 
banks to resume gold basis of payment by 1821. 

1825. Panic in London following extravagant specula- 
tion. 

Credit exhausted by loans to foreign countries. Crop fail- 
ure in England in 1824 necessitated export of gold to buy grain. 

1837. Panic in the United States. 

Panic marked culmination of speculation in land, banks, 
railways and commodities. Chief feature in 1837 was a reduc- 
tion of British commercial loans to American merchants. 

1839. Banking Collapse in the United States. 

Precipitated by withdrawal of credit from America by the 
Bank of England. The latter became weak after exporting gold 
to buy wheat from continental Europe following crop failure in 
England. 

Collapse of credit in America was needed to remove excessive 
supply of currency, as deflation had been avoided in 1837 by sus- 
pending payment, whereupon more currency was issued, espe- 
cially in the South. New York had deflated in 1838 and was 
strong financially in 1839 when Philadelphia banks collapsed. 
Financial leadership passed to New York. 



Resume of History of Panics 41 

1847. Panic in England following railway boom. 

Precipitated by export of gold to buy wheat. English crops 
had failed in 1846. 

1854. Panic in the United States upon outbreak of 
Crimean War. 

Credit restriction in London exerted financial pressure upon 
United States, where poor wheat crop and epidemic in cotton 
belt, delaying cotton exports, were adverse factors aggravating 
the crisis. Panic marked culmination of speculative boom in 
railways and banks. 

1857. Panic in Germany, France, England and the United 
States. 

General exhaustion of credit. The crisis developed normally, 
with excessive paper currency draining gold from the banks. 

1866. Panic in London, Black Friday, May 11. 

Big failures on account of tight money and declining secu- 
rity prices. New banks formed under the Companies Act of 
1862 had over-expanded. The position of one of them (Overend 
Gurney & Co.) became prejudiced by a court decision, invali- 
dating railway securities in its possession. Suspicion of new banks 
became general, and Bank of England tended to hold aloof, per- 
mitting numerous failures. 

1869. Black Friday in the United States, September 24. 

Jay Gould and other railway speculators embarrassed by 
decline in gold premium after accumulating gold in attempt to 
corner the supply. 

1873. Panic in Austria, Germany and the United States 
following railway boom. 

Tight money caused railway securities to decline, involving 
failures. Inflation during 1871-72 was stimulated by ending 



42 B u s i ne s s Cycles 

of Franco-Prussian War and the wholesale investment of French 
indemnity funds. Speculation was absent in France and great- 
est in Central Europe and the United States during the first half 
of the cycle. 

1882-84. Crisis in France following over-speculation. 

Exhaustion of credit was in evidence in France in 1882, 
but not in America until 1884, when trade reaction, resulting 
from European crisis of 1882, exerted pressure on the New 
York money market, a panic in railway stocks occurring in 
May, 1884. 

1890. Baring Panic in London. 

Precipitated by decline in Argentine securities. Poor crops 
and revolution in Argentina were responsible for the slump in 
security prices in the London Market. Baring Bros., largest 
dealers in Argentine securities, became embarrassed. Liquida- 
tion of their affairs required three years. 

1893. Panic in the United States. 

Gold driven from the country by fear that "Free silver" 
coinage might become national monetary policy and involve 
abandonment of gold standard. Foreign investors in fright re- 
turned American securities to New York and took away gold. 
Important contributing influences were the general commercial 
reaction in Europe following the Baring crisis of 1890 and a short 
wheat crop in the United States in 1893, which reduced trade 
requirements for the paper money being injected into the coun- 
try's circulation by the Treasury under the Silver-Purchase 
Act of 1890. The silver-secured paper notes were redundant 
because they were excessive in supply, and the drop in currency 
requirements on account of dull trade in 1893 made this redun- 
dancy the more aggravating and conspicuous. Capital took flight 
in fear of a change from the gold to a silver standard of paying 
obligations. Stocks and bonds were disposed of ; gold was hoarded. 



Resume of History of Panics 43 

1899-1900. Crisis in Germany, France and Russia fol- 
lowing period of expansion. 

No crisis in America, where prosperity was sustained, owing 
to large exports to Europe and an abundance of bank reserves. 
The latter was partly due to the expanding gold production in 
the Klondike, and partly to the fact that the "free silver" ques- 
tion in the United States seemed definitely settled by the election 
of McKinley in 1896 on the gold standard platform. After 1896 
the conditions preceding the panic of 1896 were reversed. The 
stoppage of silver currency inflation caused gold to return to the 
banks in growing volume. As confidence grew, moreover, Eu- 
rope repurchased American securities, remitting cash. Then 
during the Boer War, 1898-1902, England bought war supplies 
regardless of the crisis in Central Europe, so that New York did 
not have to deal with financial pressure from London for a long 
while. Central Europe experienced crisis and reaction during 
1900-1902. With the ending of the Boer War in 1902, however, 
war inflation in London ceased and normal tendencies returned. 



1903. Rich Man's Panic in New York. 

Banks, weakened by gold exports, suddenly became unable 
to carry load of new' securities. Financial retrenchment and 
readjustment in London, following the Boer War, was a con- 
tributing factor in the financial stringency in New York. 



1907. World Crisis. 

Exhaustion of credit followed a period of inflation and over- 
speculation. 



1914. Outbreak of war caused run on the banks in the 
United States. 

Trade in the United States was on a sound basis; after a re- 
adjustment period of five months, industry recovered. 



44 B u si n ess Cycles 

1921. European crisis following stoppage of American 
Loans to England and France. 

Crisis in the United States reached after continued inflation 
of loans in face of gold drain to Asia and South America. Situa- 
tion eased by free lending by Reserve Banks. The usual post-war 
deflation followed a decline in exports. Prices dropped 
sharply and most all industrial corporations suffered heavy 
inventory losses. Purchasing power was severely curtailed. 

Watching the Trend of Affairs 

Conditions in business are complex, and the business man 
has a good deal to do to keep in close touch with mat- 
ters within his own organization. But matters outside — 
such as currency inflation, condition of bank reserves, Federal 
Reserve Board policies, foreign exchange rates, etc. — essentially 
concern him, and when investing or speculating, the business 
man cannot afford to remain ignorant of these basic elements 
in the business cycle. 

Wide-awake business men agree already with what has just 
been said, and desire most of all the best means, and methods 
of correct reasoning, for interpreting the business cycle. What 
has been said in the present Text, it is hoped, will enable the 
business man more accurately to do this. 

During the next five years the most important cross-current 
will be the progress toward currency deflation in Europe. The 
rules for interpreting the "normal cycle" will still apply, but 
broad vision will be necessary in forming a correct judgment of 
the future. We will try to help in this by further detailed 
explanation in the Text, "The Search for Bargains." While it 
is the closing Text it may well be read here, if the client desires. 



Garden City Press, Inc. 
Newton, Mass. 



TEST QUESTIONS 

"BUSINESS CYCLES" 

The test questions which are unstarred can be answered 
directly from the Text discussion. You will find them helpful 
for purposes of review. 

The questions which are starred call for original thought, 
the ability to apply the knowledge gained from the Text to 
the solution of new problems. Answers to these questions are 
enclosed for consideration after your own solutions have been 
drawn up. 

1. Describe the various periods of a business cycle. 

*2. "One of my friends tells me that cycles run in ten- 
year and twenty-year periods, just as regular as the tides. Why 
don't everybody get on to this and buy or sell according to the 
dates as they come? L. J. K." What answer would you 
make to this? 

3. W r hat is the chief factor which operates to cause the 
normal cycle? What statistical indexes enable a person to 
watch the operation of this factor? 

*4. "Stock prices will have to go up," said a trader. "Every- 
thing else is inflated, why should not stock prices be inflated 
too?" Is this reasoning correct? 

*5. Are corporation profits larger, or smaller, during a 
period of rising prices than a period of falling prices? Why? 

6. Show how, by raising questions concerning cross- 
currents, one sets about formulating his financial policies. 

7. Specify various items which, as cross-currents, throw 
out of order the course of the normal cycle. 

8. In what period of the cycle are we now? (Note the 
various statistical idexes, and "The Bulletin"). 

9. Name some of the panics which have occurred since 
1720, and specify certain of the elements which appear to be 
prominent in these panics. 

*10. "Why did you leave out the gold-mining stocks in 
1918?" asked a subscriber. "Of course operating costs are 
high; that is true of all companies and not only these gold-mining 
companies. If you favor at this time industrial stocks, why 
not these?" What answer would you have made to this question? 



ANSWERS TO STARRED QUESTIONS 
"BUSINESS CYCLES" 

*2. In the Text we have discussed the normal cycle and the cross- 
currents which cause this normal cycle to vary. You will see from this dis- 
cussion how impossible it is to predict exactly what is going to occur in the 
future, with dates. What can be done, however, is to keep under close 
observation the essential factors, along with the cross-currents, and keep 
revising one's forecasts as new factors enter in or old factors change in their 
relative power. The other method, of going by dates and of dividing in- 
dustrial history into mechanical periods, is arbitrary and will not secure you 
results in the long run. The method just cited, and which is described in 
the Text with some detail, is based upon sound reasoning and will prove 
serviceable. 

*4. There are two errors in this reasoning. First, since stocks tend to 
anticipate inflation of commodity prices and business profits, it may be pre- 
sumed, if "everything else is inflated," that stocks have previously passed 
through an inflation period. Second, when everything else is inflated, there 
is an abnormal strain upon bank credit. In such a situation, as outlined 
in the Text, bankers reduce loans on securities in order to finance commercial 
borrowers. This inevitably forces stocks downward; stocks suffer that 
merchandise values may be sustained. 

*5. They are larger during a period of rising prices due to the fact that 
prices secured for the company's commodities advance faster than its costs 
in general. Likewise, when falling prices ensue, the company has to meet 
a lower sales price for its product, which product, however, has been produced 
from materials bought at old and higher figures and at a relatively high wage 
cost. 

*10. The fact that their product, gold, can be coined into, rather than 
sold for money, renders the action of gold-mining stocks different from 
those of other companies. Because the price of gold thus is fixed and neither 
goes up or down with other prices, gold stocks are among the worst in times 
of prosperity and among the best when business is depressed. They have 
done well, 1921-22. There is always a market for gold, and labor can find 
employment in the gold mines when other industries are idle. Hence, while 
industrial concerns, able as they are to advance their selling prices as the 
costs of producing their commodities rise, proved to be excellent purchases 
in a period of inflation like 1918-19, the same would not hold true of gold 
mining stocks. 



